Indian pharma no longer a growth tonic for FIIs

MUMBAI: Saddled with heightened USFDA scrutiny, a strong rupee, weak commercial potential of drugs in the pipeline, the Indian pharmaceutical sector is turning out to be a bitter pill for several large global investors.

The high sectoral risks have also led to several marquee foreign institutional investors (FIIs) cashing out of their equity positions in several companies. The latest disclosure of shareholding pattern for the quarter ended March 2017 reveals that funds as diverse as Abu Dhabi Investment Fund (ADIA), Temasek, Oppenheimer & Co and T Rowe Price, among others, have reduced their shareholding in large Indian pharma stocks like Sun Pharma, Lupin, Dr Reddy's and Cipla (see table). The combined market cap erosion of the top five Indian pharma companies has been Rs 1,500 crore over the last one year.

Temasek - which has been big on home-grown pharma companies, having backed Sun, Lupin and Glenmark - has cut its positions in the first two companies to the tune of Rs 300 crore. ADIA too reduced its holdings in Dr Reddy's and Lupin to the tune of Rs 500 crore in the last eight months.

Temasek in an email response to ET said as a policy it doesn't provide market commentary. ADIA did not respond to a mail sent by ET. “The golden days for pharma are over as they are for IT," Hugh Young, MD, Aberdeen Asset Management, Asia, told ET Now in a recent interview. “It has become a tougher industry considering the tough US policies. There is competition springing up from everywhere... It is a challenge for Indian pharma that has clearly underperformed. As a result, growth has slowed. If things slow down in an expensive area, you see ratings fall quiet sharply and the risk is that you can lose quite a bit of money as a result."

Aberdeen, which has had a dream run with Sun Pharma over the last 20 years, have a sub-10% exposure to the pharma sector in its total portfolio.“The peak for pharma and IT services is probably over in the terms of growth rates rather than overall bottom line profits. There is still scope for growth but not at the rate they were growing earlier," said Young.

“There might be more pain, investors are waiting for further bottom out before they re-enter," said an analyst of a leading brokerage firm that advises FIIs, on condition of anonymity. The lack of clarity on the regulatory side is what is concerning the investors, he added.

This sentiment has now percolated to the entire sector as investors are seeking out specific companies to invest in the madcap space, even if many feel valuations of many are still at a premium.

“Most investors, while looking for ideas, had concerns on the rising event risks. We had multiple conversations on the high uncertainty in earnings and how valuations are still not in the comfort zone. We highlighted that pharma investments need to be bottom-up and not a top-down calls, going forward," said Piyush Nahar and Anurag Mantri, pharma analysts at Jefferies, after a recent Asia roadshow for global investors. Interestingly, according to Jefferies, investors were bullish on healthcare service providers like Narayana Hrudayalaya instead of largecap pharma stocks.

“FDA issues dominated most conversations. These will require substantial re-training, changes in incentive policies and strict monitoring through consultants and internal compliance," they added. Last two years have been one of the toughest for Indian pharma companies who have been badgered by repeated inspections by the US drug regulator, the move has hit the exports and sales in US market that contributes to nearly 40% to large pharma companies' revenues. Adding to this is the charges of price cartelisation that some Indian companies are facing in the US.

India exports close to $13 billion worth of drugs across the world, a fifth of which are to the US.

“The rupee's sharp and surprising 5%-plus appreciation from January 1 has been good for the markets," argues Prateek Parekh, an analyst at Edelweiss in his April 17 report while predicting that “a 4% earnings cut (if the rupee goes to 62), and with nearly 50% of Nifty earnings FX linked will hurt IT, pharma, commodities and autos." However, domestic investors have stepped in to increase exposure in these companies. Among those are mutual funds and insurance companies that have increased holdings in all the large companies. Prevailing low valuations and long-term pharma story are the reasons domestic fund are still enthusiastic about this sector, said a fund manager of a domestic mutual fund.

Domestic funds like ICICI Prudential Mutual Fund, Reliance Capital Mutual Fund, Franklin Templeton have increased their holdings steadily in large pharma stocks taking advantage of the falling valuations. The total investments combined are in the tune of Rs 500 crore.

“Year 2009-15 was good for pharmaceuticals, but 2016 was a bad year because of the concerns around pricing, compliance issues and the fear of shrinking growth in the large US market despite Indian pharma companies having strong competitive advantages," said Sunil Singhania, CIO, Reliance Mutual Fund. “Now, most of the regulatory worries are behind us, valuations look attractive and many companies have started getting new product approvals."

Ace investor Rakesh Jhunjhunwala has also increased his investments in midcap companies like Aurobindo Pharma even though data show he has partly exited Lupin, where he has been a long-term investor.

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